So before we even talk about the US Federal Reserve warning of pending interest rate hikes, why does what the Fed says matters to Canadian mortgage borrowers?

Canadian monetary policy is heavily influenced by US monetary policy because our economies are deeply interlinked (we export about 80% of what we sell abroad into U.S. markets); because the US economy is about ten times larger than ours, and; because the Fed funds rate is essentially the global economy’s single most important interest rate.

There is always a delicate balance between the relative monetary policy positions of the Bank of Canada (BoC) and the US Fed. Subtle changes in our respective outlooks can influence the US/Canada exchange rate, which has its own profound impact on our economic momentum.

The most recent Canadian example of this phenomenon was seen when BoC Governor Poloz expressed repeated concerns about the negative impacts of sharply lower oil prices on the Canadian economy. His comments helped drive the Loonie lower, giving our exporters a competitive boost in the process.

Last week it was the Fed’s turn – it offered markets its latest perspective on the strength of the US recovery. Each Fed statement is carefully parsed by investors, who try to determine when it will finally begin to raise the funds rate from its current 0% to 0.25% range, where it has hovered since December 16, 2008. The funds rate is important because it acts as the base rate on which all other US interest rates are either directly or indirectly based, so when it rises, almost all other US rates would be expected to follow.

Investors have long expected that the Fed would first remove the word “patient” from its interest-rate guidance as an early-warning signal that its policy rate would begin to rise in the not-too-distant future. That expectation is based on precedent because in January of 2004, the Fed dropped the word “patient” from its forecast and then hiked its funds rate six months later.

Interestingly, the Fed did finally do exactly that last week. But in an unexpected twist, the tone of its overall communication was actually more cautious. So while the momentum of the stock and bond markets in the lead up to last Wednesday’s announcement was bearish, markets were quickly re-priced with a lower-for-longer interest-rate view immediately following the Fed’s actual announcement. Markets quickly lowered the odds of a September rate hike from 53% to 38%, and decreased the odds of a rate hike by year end from 77% to 64%.

Canadian fixed rates are driven by the strength of the bond market here in Canada, which is in turn heavily influence by the bond market in the US. With the US economy strengthening and US rates increasing, we will definitely see Canadian fixed rates follow the overall pattern in the US.